Could Credit Collapse?

July 17, 1961

At the end of June there was a minor “gold rush” in Europe. Some dispatches attributed the increase in demand for gold to a series of articles published in British and Continental newspapers by Jacques Rueff, the French economist and financier. Rueff argued that unless the present international monetary system was changed, the world was heading for another crash of the proportions of that of 1929.

He has also put this argument forward in the July issue of Fortune. A great peril, he contends, hangs over the economy of the West. “The instability in our monetary system is such that a minor international incident or . . . disturbance could set off a worldwide disaster.” The measures suggested for dealing with this peril fail to go to the roots of what is wrong. “The nature of the disease is apparent in this fact: During the decade 1951–60, while the U.S. was piling up balance-of-payments deficits totaling $18.1 billion, some $13 billion accumulated in foreign hands in the form of sight deposits or short-term investments in the United States money markets. This $13 billion constitutes a claim on the U.S. gold reserve that could be called at any time—with catastrophic consequences.”

A ‘PRODIGIOUS ERROR’

“This came about because, in the countries that were creditors to the U.S., the central banks were content to accept dollars in settlement instead of demanding payment in gold. . . . Paradoxically, the danger we are in was brought about not because the U.S. lost gold, but because it lost so little gold. During the decade U.S. gold reserves fell by only $5.3 billion. If the U.S. had settled its balance-of-payments deficits entirely in gold, its reserves would have dropped—all other things being equal—by $18.1 billion, and today they would amount to a mere $4.7 billion. By all the evidence, such an unthinkable drop in reserves would not have been tolerated. Action would have been taken much earlier to stop the deficits.”

Rueff concludes that “the American balance-of-payments deficits were allowed to persist for the last ten years only because the U.S. was not really required to settle its debts abroad.” This situation “is the product of a prodigious collective error.”

This error, in Rueff’s opinion, was the passage at the International Economic Conference in Genoa, back in 1922 (eleven years before the U.S. went off the gold standard), of Resolution 9, which recommended adoption of an international convention embodying “some means of economizing the use of gold by maintaining reserves in the form of foreign balances.” This brought into existence the “gold exchange standard,” under which central banks consider themselves authorized to create money not only against gold or government bonds, but also against any foreign currency considered as good as gold.

CREDIT PYRAMID

Under this system, the U.S. has enjoyed a “deficit without tears.” Foreign countries could leave their dollars on deposit with us, thus enabling us to continue building credit on them, while they built their own inverted pyramid of credit on them. It is this “double pyramid of credit” that is in danger of toppling.

What is the remedy? Rueff rightly points out that it is certainly not the Triffin plan, which would give the International Monetary Fund the power to issue its own international money and increase the world inflation. He quite properly insists, also, that we must eventually “liquidate the unstable and dangerously vulnerable situation resulting from the duplication of the credit structure, built on the gold reserves of those currencies with key currencies.”

It is when he gets to this point that Rueff’s otherwise brilliant discussion becomes unsatisfactory. He is right when he insists that we must halt both the U.S. and the world inflation. But we cannot tolerate an American or a world deflation either. This would almost certainly be the consequence of any attempt, however gradual, to “pay off in gold [presumably at $35 an ounce] all the dollar assets held by central banks outside the U.S.” First of all (preferably through a transitional free market in gold) we must get back to a tenable gold rate for today’s depreciated dollar.